MODULE 2: ECONOMIC GROWTH AND DEVELOPMENT
Economic growth:
Economic growth can be defined as an increase in the
capacity of an economy to produce goods and
services, compared from one period of time to
another. Economic growth can be measured in
nominal terms, which include inflation, or in real
terms, which are adjusted for inflation.
“Economic growth is necessary to keep the promise
that each generation will have the opportunity to
become more prosperous than the preceding one, the
popular term for which is 'the American dream.”
-Michael Mandelbaum
What is economic growth?
• An increase in real GDP occurring over some time
period
• An increase in real GDP per person occurring over
some time period
Note the term REAL.As we have already learned, this
suggests that growth exceeds the inflation rate. In
other words, purchasing power is increasing. We are
able to buy more!
Why do we care? Because growth lessens the burdens
of scarcity
How is economic growth measured?
 Economic growth in a country is measured by
the country’s Gross Domestic Product (GDP)
in one year
 GDP = the total amount of final goods and
services produced in one year within a
country. All finished good and services should
have a monetary value.
 GDP is used to track the health of the
economy. How healthy is the economy?
 Consumption and investment are part of the
calculation of GDP. If there is growth then
purchasing power is high. People are buying
and investing.
 GDP used by economies to determine if an
economy is growing or experiencing a
recession.
 GDP can be used by investors to aid their
decisions in investing.
 Bad economy = income is low, stock prices are
low
 In 1 year we have quarters to measure in gdp
For centuries, GDP per capita was unchanged
 The primary inputs for production were land
and labor.
 Since land was constant, if you wanted to
produce more, you added more labor.
 Therefore, output per person didn’t really
change much.
 In fact, economists have estimated that Real
GDP per person in much of the world was
relatively unchanged during the entire 300 BC
to 1500 AD period!
-…..
- Land was constant
The catalyst: Industrialization
 Then something happened…
 James Watt (1736 - 1819) a Scottish inventor
and engineer radically altered the steam
engine
 This allowed a movement from production by
hand to production in a factory
 It also allowed an easy flow of inputs and
goods
 Factories sprang up and people began to
move to cities for employment
Industrialization spread quickly
 Since the technology was born in the U.K. the
economy there quickly industrialized. This
technology quickly spread to Western
Europe… …then to its colonies.
 Note how each of these “early adopters” is
among the world’s leaders in GDP per capita.
 Japan industrialized in the 1850s.
 Asia and Latin America industrialized
beginning in the 1900s. Their per capita GDP
growth has not risen to the same heights as
the more industrialized nations. International
trade is a key catalyst for spreading
technology.
- Catalyst for spreading technology
- Just because a country is behind does not
mean it cannot catch up
-
However, just because a country is behind does not
mean they cannot catch up!
 Our Real GDP growth rate is typically slower
than many other countries It is easy to see
that the rapidly developing countries of China,
iIndia, and Brazil could gain on the U.S.
  U.S. GDP growth has averaged about 1.8% in
the last decade.
In fact, the rule of 72s suggests that they will!
 The rule of 72’s states that a variable
approximate doubling time equals 72 divided
by its growth rate.
 If US Real GDP grows by around 3% per year,
that means that it will take about 24 years for
Real GDP to double.
 If China, for example, is able to continue to
grow its economy at 8% per year or more,
then its Real GDP will double every 9 years.
 At such a rapid rate, it’s easy to imagine that
one day China’s economy will overtake the
U.S. as the world’s largest.
Short run versus long run growth
 We’ve learned that short run factors such as a
wealth effect can push AD higher.
 In that case, we see economic growth – here
Real GDP has increased from $200b to $250b.
 However, this results in an inflationary gap.
This economy is beyond its long run potential
and unemployment is low.
 It won’t take for workers long to figure this
out and start demanding raises.
 And if they get them, then employers will
have no choice but to raise prices…that is
inflation! AD1 “Inflationary Gap”
-if people have more income and they have
more wealth then they can buy more
products.
-inflationary gap meaning the economy is
beyond its long run potential.
-workers will start demanding increase of the
minimum wage.
-short-run growth = less thaqn 6 months’ time
period.
-factior of production is fixed like income
Long run growth is the ultimate goal
- All factors of production are variable.
- A firm for example can build a bigger
factory or a firm can expand its
building/warehouse.
- Time period: 4 – 6 months or even a
year.
- Increase in national output and national
income. (economic growth)
- FACTORS OF ECONOMIC GROWTH:
- Increase in aggregate demand
- Consumption +government spending+
export - import
- HIGHER REAL WAGES WILL INCREASE
CONSUMPTION
- DEVALUATION WILL INCREASE EXPORTS
WILL DECREASE IMPORTS BECAUSE IF
YOU ARE EXPORTING YOU GET PAYED
- Increase in government spending
- Lower in interest rate
- Increase in aggregate supply
- Long-run aggregate supply
- Increased investment
- Higher labor productivity
- Discover raw materials
- Increase labor force
- Improve technology
 In order to obtain sustainable long run
growth, the LRAS must shift outward.
 That allows Real GDP growth to occur without
the dangerous effects of inflation.
 History is replete with examples of rapid long
run economic growth.
Three of these really stand out:
•The Agricultural Revolution (10,000 BC)
•The Industrial Revolution (1750-1850)
•The Information Revolution (1960-now)
What causes long run economic growth to occur?
There are numerous factors, but two in particular
stand out:
 Increases in the quantity of labor
 Increases in the quality of labor
Ingredient #1: Increases in the quantity of labor
 As can be seen in the graph, the U.S. has
added to its quantity of labor in almost every
year.
 In fact, our labor force has grown from 60
million in 1948 to almost 160 million in 2009!
 Labor Force - The total number of people
employed or seeking employment in a
country or region. Sometimes called work
force. Source: U.S. Census Bureau.
We are lucky!
 Not everyone has a growing labor force!
 In Japan and other places, a shrinking
workforce does not bode well for future LRAS
growth. Source: World Bank
Ingredient #2: Increases in quality of labor

 The second ingredient to long run economic

growth is to make existing labor more
productive.
 That can be done by offering training, using
better technology, or providing better tools.
 My favorite example may be related to
garbage collection. When I was a kid, it took
three employees to collect garbage: one to
drive the truck and two to collect trash.
 Today it takes only one in a truck with a claw.
That frees two employees to do something
else…thereby increasing the economy’s
potential.

14. Slide 14 of 18 Increases in quality of labor can be

delivered in a number of ways Technology Education
and training Increased capital Improvements in
efficiency For example, employees trained in a new
procedure may produce more or avoid output
reducing errors. For example, employees given
computers may be able to process more transactions
or complete more sales. For example, employees
given tools, like this 18- wheeler-may be able to haul
more For example, employees allowed to
telecommute may become more productive.

1 Slide 15 of 18 Increases in quality of labor can be

delivered in a number of ways Technology Education
and training Increased capital Improvements in
efficiency In theory, each of these would lead to
greater productivity Productivity – a measure of
output per unit of input. For example, the number or
value of manufactured goods each employee can
produce per hour.

Inflation is the increase of the prices of goods and

services. If prices are too high consumers will buy less.

If demand is low because of the inflation then the

business sector. Inflation distorts business decisions.

Tax levels:

Products increase prices because of taxes. Interest

rates will also impact then economy.

Inflation adjusted measures that reflects the value of

goods and services produced in an economy in a given
year.

Real GDP per capita is per person. Compare the

standard of living from other country overtime.